Extraordinary Games Businesses 2: Giant Interactive

For this month’s column I want to continue our look at some of the most interesting, innovative and successful companies operating at the fringes of the games industry by turning our attention to Giant Interactive Group.

Giant is a NASDAQ-listed but Shanghai-based MMO developer and operator focused almost exclusively on its indigenous Chinese market. Despite being less than five years old and having only released its first game in ‘06, Giant has grown rapidly, with sales of $233m in 2008. What distinguishes it from others in the Chinese market and, indeed, from pretty much every other games company on the planet, is its profit margins.

Net profits in 2008 were $163m, an astounding 70 per cent net income margin. This was not even an exceptional year for Giant. 2007 net profits were $156m, a 75 per cent margin. Most traditional games publishers would be delighted with a 15 per cent net income margin, but not even EA or the WoW-propelled Activision Blizzard ever achieve this. Yes, those with some financial understanding might argue that net income is not the best tool for comparing profitability, but with every profit measure Giant’s results are remarkable.

THE MAKING OF A GIANTThe secret to Giant’s success has been its ability to generate Western market Average Revenue Per Paying User (ARPPU) levels from a Chinese player base. So whilst most Chinese operators tend to generate ARPPU of $5 to $7.50 per month, Giant makes $14.60 ARPPU per month from its paying user base of over 1.2m. Again, to add some Western perspective, Blizzard generates around $8 per month from its WoW players (excluding retail sales) although this obscures differences between Asian licensing and directly monetised Western subscriptions.

Digging deeper into Giant’s performance uncovers an array of novel game design elements and commercial strategies. It also reveals no small amount of controversy, largely centred on the aggressive commercialisation built into its small portfolio of microtransaction-based games and, in particular, the randomised loot purchases in its key title ZT Online. Players pay around $0.15 for a key to open a treasure chest that yields random virtual items. Upon opening, the chest reveals a slot-machine-like display that spins through rare items before usually settling on a more common item. In addition to the low chance of gaining rare and valuable items, there is a significant gameplay prize for the player that opens the most chests on any given day. Because other player tallies are kept secret, players can purchase thousands of keys and still not come out top.

The result has been vituperative accusations of gambling and exploitation, and there is no doubt that these commercial practices are at the heart of Giant’s unprecedented financial performance. However, the mechanism appears little different to collectible card games such as Magic Online and even EA’s recent BattleForge, which are similarly based around randomised card pack purchases and the injection of artificial scarcity.

Giant did not invent the concept of gameplay-enhancing virtual item sales, but it both popularised it and took it to a new level in China. Progress in ZT Online is inextricably linked to how much players pay. Players can play for free but will constantly face glass ceilings. As we have pointed out in previous columns, this is fast becoming the standard for new MMOs in the West, although perhaps not to the extremes utilised by Giant. One of these extremes is the sale of ‘insurance’ to ZT Online players: players can insure (i.e. wager) against their progress in the game, receiving pay-outs potentially greater than their initial investment as they reach various in-game levelling milestones. As players must invariably pay to progress, Giant always wins.

In many ways, ZT Online was uniquely designed for a middle class audience of time-poor but wealthy players that are able and willing to spend money to avoid the time-consuming grind necessary to make early progress in most other MMOs. To reinforce this approach, Giant did something very novel: it established over 500 local sales offices and hired over 3,000 ‘liaison officers’ (i.e. sales staff) tasking them with travelling the country to promote Giant’s games and recruit new players. These staff would visit internet cafes and talk players into trying Giant’s games over other operators’ titles.

However, Giant’s rampant commercialisation eventually ruffled enough players’ feathers and resulted in extensive in-game protests. As a result, the company recently adopted a pacifying measure of launching several variants of ZT Online with differing levels of commercialisation. Interestingly, the most aggressively commercial version remains extremely popular and continues to grow. The financial result, however, has been a fall in net profit, although its Q1 2009 margin was still over 62 per cent. Not that the company is worrying too much: it raised $886m when it floated in 2007, it still has $763m sitting on its balance sheet and its current market capitalisation is $1.84bn. It is also one of the only listed games companies financially confident enough to pay a dividend.

The moral of this story is therefore that, whilst there is a limit to how much commercialisation you can get away with, it is almost certainly higher than you might expect.

…

Nick Gibson is a director at Games Investor Consulting, providing research, strategy consulting and corporate finance services to the games, media and finance industries.www.gamesinvestor.com